The ECB and Bank of Japan are winning for now in the bond market lottery

by Shaun Richards

The last couple of weeks or so ( strictly speaking since the 15th of June) have seen the tectonic plates shift in bond markets. As ever they will have caught out the unwary and my choice of the 15th of June raises a wry smile because of this.

In support of these goals, the Committee decided to
raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent and anticipates that ongoing increases in the target range will be appropriate. ( US Federal Reserve )

So a 0.75% increase in interest-rates plus some reversing of the QE bond purchases or what is known as QT ( Quantitative Tightening).

In addition, the Committee will continue reducing its holdings of Treasury securities and agency
debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May.

So economics 101 would have bond yields rising and we can bring that up to date with Lisa Abramowicz of Bloomberg earlier.

The final remnants of the “transitory” concept were annihilated yesterday as top central bankers formally recognized a new inflation paradigm.

Let me continue with the Bloomberg theme.

For Powell and his colleagues, a conclusion that underlying inflation is at risk of drifting higher and becoming unmoored from the Fed’s 2% target could spell an even-more aggressive policy pivot than suggested by their June forecast.

They really do warm to their task.

That outlook — which already shows the most hawkish Fed action since the 1990s, projects rates rising another 175 basis points this year and peaking between 3.75% and 4% in 2023. The following year, however, officials pencil in modest rate cuts as growth moderates and inflation turns back toward target.

So at this point we can join the media and economics 101 dots and think that in terms of the benchmark ten-year yield it will have gone from the near 3.5% it made pre Fed to somewhere more like 3.75% now?

Whereas the reality this morning is this.

The US ten-year Treasury yield dropped below 3% this morning to trade at 2.96%. ( Global Reach Group)

So there has been something going on and we can start with something we have both expected and feared.

The US Economy

The Atlanta Fed released this yesterday.

The GDPNow model estimate for real GDP growth (seasonally adjusted annual rate) in the second quarter of 2022 is -1.0 percent on June 30, down from 0.3 percent on June 27.

So markets were forced to address the situation we thought was in play which is of a US recession being in play now. It was the consumer ( a real life example of our weak real wages theme) which drove this, plus perhaps firms anticipating lower demand.

After recent releases from the US Bureau of Economic Analysis and the US Census Bureau, the nowcasts of second-quarter real personal consumption expenditures growth and real gross private domestic investment growth decreased from 2.7 percent and -8.1 percent, respectively, to 1.7 percent and -13.2 percent, respectively,

The situation is that personal consumption expenditures fell by 0.4% and that in addition April was revised lower by 0.4% and March by 0.2%. So suddenly the US consumer is starting to struggle or rather the official data has picked it up.

Bank of Japan

Back on the 17th of June we looked at the way that the Bank of Japan was continuing its policy of Yield Curve Control where it will not let Japanese Government  Bond ten-year go past 0.25%. There has been a clear side-effect which has been a fall in the value of the Yen which nudged 137 versus the US Dollar earlier this week.

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However the Bank of Japan gritted its teeth at the time and pressed on.

Deutsche Bank estimates that the BoJ has spent $72bn buying bonds just this week, almost what Fed and ECB were doing in an entire month last year. Adjusted for the different sizes of their respective economies, the pace of Japanese QE this week is more than 20 times the pace of the Fed’s in 2021. ( FT Alphaville)

Regular readers will recall that Blue Bay and some others have taken them on as this from Jens Nordvig on the 25th of June highlights.

We crunch thousands of capital flow data series on a weekly basis at @ExanteData This is the most interesting data series this week: Foreigners are dramatically accelerating their selling of Japanese Government Bonds (almost $40bn sold in the latest week!)

Such things have consequences as Nikkei Asia points out.

The BOJ purchased JGBs worth 14.8 trillion yen ($110 billion) in June, surpassing the 11.1 trillion yen purchased in November 2002, its largest monthly total.

According to the QUICK database, the outstanding value of long-term JGBs as of June 20 totaled 1,021.1 trillion yen, of which the BOJ held 514.9 trillion yen on a face-value basis. That translates to 50.4% of the total amount outstanding, up from 50.0% in February to March 2021.

We can note from the next bit the impact of Abenomics.

The central bank’s JGB holdings were in the 10% range when Gov. Haruhiko Kuroda started the massive monetary easing program in 2013. Its holdings have swelled as the policy meant to bring Japan out of deflation has dragged on.

Rather curiously we have now entered a period which is more Abenomics than Abenomics was. Maybe they are aping John Law

European Central Bank

Next up is the ECB which as we looked at on Wednesday needs to get back in the bond buying game but is supposed to be on a “journey” to tighter monetary policy according to its President Christine Lagarde. Then yesterday afternoon emerged an example of what we have come to call “sauces”.

SINTRA, Portugal, June 30 (Reuters) – The European Central Bank will buy bonds from Italy, Spain, Portugal and Greece with some of the proceeds it receives from maturing German, French and Dutch debt in a bid to cap spreads between their borrowing costs, sources told Reuters.

Whilst this contradicts the claim from President Lagarde that the details would be kept secret it was what we were expecting with one surprise.

The ECB will kick off this rebalancing on Friday to prevent financial fragmentation among euro zone countries from getting in the way of its plan to raise interest rates – with an additional scheme due to be unveiled next month

So it starts today and the winners are…

Recipients include a handful of countries perceived by investors as riskier due to their high public debt or meagre growth, such as Italy, Greece, Spain and Portugal, the sources said.

The losers?

The donor group is made of around half a dozen so called core countries considered safer and includes Germany, France and the Netherlands, according to the sources.

So they will be reinvesting maturities early and also switching them to the more vulnerable bond markets.

It rather echoes Hot Chocolate.

So you win again, you win again
Here I stand again, the loser
And just for fun you took my love and run,
But love had just begun


The strategic move here has been the realisation that the economic  outlook is not only grim but that it has already arrived. This has pulled bond yields lower and has been the strategic move. It means that life has been made easier in a tactical sense for the Bank of Japan too. The babarians at the gate from its point of view have been easier to resist. Some will have sold Japanese bonds and bought elsewhere continuing the game.

If we switch to the ECB it has also benefited from the bond market rally with the ten-year yield of Italy at 3.35% rather than the over 4% it was. Although it is awkward as it means it is buying the bonds more expensively ( something central bankers always gloss over). But there are two further moral hazard problems.

  1. The ECB will build up a balance sheet of bonds that nobody else wants
  2. If you only buy the bonds of the weaker more indebted nations then you encourage others to become more indebted. You also weaken the stronger nations.

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